Short term decision making Flashcards
Steps of the Decision-making Model
1) Define the problem and uncertainties
2) Seek out alternatives and obtain information
3) Evaluate quantitative elements
4) Evaluate qualitative elements
5) Make decisions & implement
What are the four typical short-term decisions a business has to make?
1) Limiting factor
2) Special Price
3) Outsourcing
4) Discontinuation
Characteristics of absorption costing
Long-term decisions in stable market conditions. Classification by type i.e. cost related to product and not directly related to the product.
Characteristics of marginal costing
Short-term decisions. Classification by behaviour and relevance to decision i.e. variable or fixed.
Limiting factor analysis
1) Identify the limiting factor
2) Calculate product contribution per unit of limiting factor
3) Rank products from highest to lowest contribution per unit of limiting factor
4) Allocate the limiting factor resource to products according to rank until exhausted
Issues with limiting factor analysis
1) Lose customers for whatever isn’t produced
2) Ignores longer-term picture
3) Lose customers buying multiple products
What makes a cost or revenue relevant?
1) Cash flow- there must be a movement of money
2) Future- The flow of cash must arise in the future
3) Incremental- The cash flow must arise as a direct result of the decision
4) Avoidable- this refers to whether costs can be saved if the decision is made
5) This refers to an incremental amount of a cost as a result of a decision
6) This is the value of a lost opportunity as a result of taking a decision
What makes a cost non-relevant?
1) Sunk cost
2) Committed- would occur regardless if the decision was made
3) Notional- this refers to common fixed costs which have been apportioned
If there is spare material from previous overbuying
The relevant cost is the higher of NRV or the saving from substitution.
Two formulae for contribution
Sales revenue - variable cost
Fixed cost + P/L
How to calculate special price
Find the relevant and irrelevant costs and re-calculate costs. Then add up and see if taking on the special order will lead to a loss or profit.
Issues with special price
1) Customers may start expecting this price
2) Ignores long term picture
3) Other customers may expect this price
How to find the cost of outsourcing
Variable cost to produce A + Lost contribution from production of B = Total cost to make
Issues with outsourcing
1) Ignores long-term picture
2) Loss of control
3) Ignores hidden cost of quality assurance
4) Redundancy of workers
What to remember when calculating whether to discontinue
Don’t forget to calculate the contribution of the discontinued items
